Unit 2 Flashcards
What is Macroeconomics?
The performance of an economy as a whole
How many Macroeconomic Objectives are there?
Seven
What are the Macroeconomic Objectives?
- Economic Growth
- Low Unemployment
- Low + Stable Inflation
- Balance of Payments Equilibrium on Current Account
- Balanced government budget
- Protection of the Environment
- Greater Income Equality
What are the 4 Main Macroeconomic Objectives, and what do these aim to provide?
Economic Growth
Low + Stable Inflation
Low Unemployment
Balance of Payments Equilibrium on Current Account
These aim to provide macro-stability.
What is Economic Growth as an objective?
In the UK, the long run trend of economic growth is about 2.5%.
Governments aim to have sustainable economic growth for the long run.
In emerging markets/ developing economies, governments might aim to increase economic development before economic growth.
What is Low Unemployment as an objective?
Governments aim to have as near to full employment as possible. They account for frictional unemployment by aiming for an unemployment rate of around 3%. The labour force should also be employed in productive work.
What is Low and Stable Inflation as an objective?
In the UK, the government inflation target is 2%, measured with CPI.
This aims to provide price stability for firms and consumers, and will help them make decisions for the long run. If the inflation rate falls 1% outside this target, the Governor of the Bank of England has to write a letter to the Chancellor of the Exchequer to explain why this happened and what the Bank intends to do about it.
What is BoP Equilibrium as an objective?
Governments aim for the current account to be satisfactory, so there is not a large deficit. This is usually near to equilibrium.
A balance of payments equilibrium on the current account means the country can sustainably finance the current account, which is important for long term growth.
What is Balanced Government Budget as an objective?
This ensures the government keeps control of state borrowing, so the national debt does not escalate. This allows governments to borrow cheaply in the future should they need to, and makes repayment easier.
What is Protection of the Environment as an objective?
This aims to provide long run environmental stability. It ensures resources used are not exploited, such as oil and natural gas, and that they are used sustainably, so future generations can access them too. Moreover, it means there is not excessive pollution.
What is Greater Income Inequality as an objective?
Income and wealth should be distributed equitably, so the gap between the rich and poor is not extreme. It is generally associated with a fairer society.
What is GDP?
Gross Domestic Product
GDP is the total market value of all goods + services produced in the country in a given year.
GDP does not include earnings by its residents while outside of the country
For example, the Toyota company is in the UK- that will be included in GDP.
What is GNP?
Gross National Product
(In reference to the UK)
Everything that is produced by UK businesses + workers, regardless of where they are in the world.
- For example, the Toyota company runs in the UK, but is part of Japan’s GNP, and not the UK’s.
What is GNI?
Gross National Income
GDP, plus Income paid into the Country by Other Countries, for such things as Interest + Dividends, Overseas Profits, etc.
How do you Calculate Real GDP?
Quantity of Product x Price of Product in Base Year
What is the More Useful GDP to measure Standard of Living, and Why?
Real GDP
- Nominal GDP is always exaggerated, and it’s not a true reflection of the country’s GDP.
- You need to consider Real GDP in order to have a reflection of the country’s living standards.
What is the GDP Deflator Formula?
( Nominal GDP / Real GDP ) x 100%
What is Nominal GDP?
The value of Goods + Services measured using Current Prices
Aka, it includes Inflation/ doesn’t adjust inflation
What is Real GDP?
The Value of Goods + Services at Constant Prices
It is adjusted for inflation
What is Meant by GDP Per Capita?
Income per Person
Usually measured as an average of the Whole Population
How do you Measure GDP Per Capita?
Country’s GDP / Country’s Population
What are the Advantages of GDP?
- Frequent: GDP is usually provided on a Quarterly basis
- Used Widely: Practically every country in the world uses some sort of GDP
- Consistent: Measured consistently
- Easy to Calculate + Interpret
Why is National Income Measured?
- The government + economists use the figures to Forecast Changes in the Economy
- Helps the government to make decisions about Taxes + Government Spending
- Helps make Comparisons Over Time
- Helps make Comparisons Between Countries
- Helps make judgements about Economic Welfare + Standard of Living
What are the Limits to GDP as a measure of Economic Growth?
- Inaccurate: Methods of Recording GDP are Imprecise
- Unpaid Work: Doesn’t take into account charity work/ volunteering
- Subsistence: Farmers may Consume what they Produce, which isn’t included in GDP
- Black Market: Doesn’t take into Account the Black Market
What are the Limits to GDP as a measure of Standard of Living? (what does it not take into account)
Quality of Life
Pollution Levels (Externalities)
Income Distribution
Population Size + Age Distribution
Quality of goods (esp technological goods)
What is Purchasing Power Parity?
This is a theory that estimates how much the exchange rate needs adjusting so that an exchange between countries is equivalent, according to each currency’s purchasing power.
For example, if a car cost £15,000 and the exchange rate between the UK and the US is 1.5 £ per $, then in the US, the car should cost $10,000. This means both cars cost the same number of US dollars, and the same number of pounds Sterling.
What is meant by Total GDP?
The combined monetary of all goods + services produced within a country’s borders during a specific time period
What is the UK’s National Wellbeing?
The Office for National Statistics is trying to develop more ways of measuring national well-being. It should give a wider picture of society and the standard of living within the UK.
In the UK in 2012, 91% of people were satisfied with their family life.
Those in Iceland were the most satisfied in the world, where 95% were happy.
Greece has the lowest life satisfaction rating of the OECD countries, as of 2015.
What is the Relationship between Real Incomes, and Subjective Happiness?
Generally, the higher the GDP per capita, the higher the average life satisfaction score.
However, the UK economy grew by 5% in GDP per capita between 2007 and 2014, but showed no change in life satisfaction.
What is Happiness Economics?
Happiness Economics tries to measure any factor that is associated with increased/decreased levels of Subjective Well-Being
This may include things like political freedom, or family relationships
How can Happiness be measured?
Many economists claim that ‘psychological surveys’ can give a reliable measure of how happy and satisfied people are with their lives.
What is the National Well-Being programme?
The ONS runs the National Well-being programme
It records statistics concerning (e.g.) peoples health, relationships, education and finances; along with people’s own assessment of their personal well-being.
The aim is to help the government devise policies that achieve better outcomes in those areas that are particularly important to people.
What is the Easterlin Paradox?
GDP doesn’t necessarily have a positive correlation with happiness
When incomes are not sufficient to meet basic needs, increasing GDP does lead to greater happiness
People in rich countries tend not to be much happier than those in poor countries; and as people get richer, their happiness levels generally don’t increase along with their income
What did the 2016 Happiness Ratings show?
Anxiety increased slightly
Happiness stayed unchanged
What is the Difference between Volume and Value?
Value: something’s monetary worth
Volume: the amount/quality of something
What is Inflation?
The rate at which the general level of prices for goods and services is rising
What is Disinflation?
A reduction in the increasing rate of Inflation
What is Deflation?
The rate at which the general level of prices for goods and services is falling
Who are Debtors?
People who owe money to the businesses (e.g. Consumers)
Who are Creditors?
People who you owe money to (e.g. Suppliers, Banks)
What is the RPI?
Retail Price Index
Includes mortgage repayments, (which can have distorting effects)
What are the ways that inflation can be measured?
CPI (main way)
RPI (alternative)
What is CPI?
Consumer Price Index
Like RPI, but Excludes:
o House Prices
o Council Tax
o Mortgage Interest Payments
The Government tends to use CPI
What is meant by the Rate of Inflation?
The Change in Average Prices over a given period of time
What is meant by the Cost of Living?
The quantity of goods + services that a Given Amount of Money will Buy for a typical household
(e.g £1000 a month)
What is RPIX?
- This is RPI, but with mortgage payments removed
How is CPI Calculated?
- Survey: The Family Expenditure Survey is sent to around 10000 different UK households from around 150 different locations- they track where/how much/ what they spend their money on, over a 2 week period
- Basket: A Typical Basket of Goods is created - the 700 (approximately) Most Commonly Used Goods + Services in a Variety of Outlets
- Weights: Weights are Attached to Signify Importance (the Proportion of that Good within all goods). They weight it by the % of income spent on it, and is between 0 and 1
- Base Year: A Base Year is selected, to use their price level. They give it an index of 100
- Measure: Index numbers are generated, showing the rate of change in inflation. There is a monthly collection of data.
- Re-do over time: The basket of goods + services and weights can be changed every year
What are the Limitations of RPI/CPI as a measure of price level/ inflation?
- There is No Typical Family- it may not be representative of all consumers
- New Goods must be Included, and Goods No Longer in Use are Removed
- RPI/CPI Doesn’t take the Quality of these goods into account
- If the basket Changes, it’s hard to compare the basket with past baskets
- May be Inaccurate/ have errors
- Other countries may use different measures- hard to compare between countries
What are the Consequences of Inflation?
- “Shoe-Leather Costs” : As the price of things increase, people will take time to search and discover more about prices
- “Menu Costs” : Restaurants are Forced to Show Increased Prices
- Money Loses its Value, and People Lose Confidence in Money, as the Value of Savings is Reduced
- Firms’ Real Incomes Fall
- Price Increases leads to Higher Wage Demand so People can Maintain Living Standards -> This can lead to Inflation Getting Out of Control (Wage Price Spiral)
- Disrupts Business Planning, Leading to Lower Capital Investment
- Possible Cause of Long Term High Unemployment; due to a Lack of Competitiveness
- High Inflation = High interest Rates = Less E. Growth = Possible Recession
What is the ‘Deflationary Spiral’?
Demand side deflation can cause a deflationary spiral, where the price level doesn’t stop decreasing
It’s very hard to get out of.
e.g. Japan’s price level
What does the CPI do?
It measures household purchasing power with the Family Expenditure Survey. The survey finds out what consumers spend their income on. From this, a basket of goods is created.
The goods are weighted according to how much income is spent on each item. Petrol has a higher weighting than tea, for example. Each year, the basket is updated to account for changes in spending patterns.
What are the Consequences of Inflation on Firms?
With high inflation, interest rates are likely to be higher, so the cost of investing will be higher and firms are less likely to invest.
Workers might demand higher wages, which could increase the costs of production for firms.
Firms may be less price competitive on a global scale if inflation is high. This depends on what happens in other countries, though.
Unpredictable inflation will reduce business confidence, since they are not aware of what their costs will be. This could mean there is less investment.
What are the Consequences of Inflation on the Government?
The government will have to increase the value of the state pension and welfare payments, because the cost of living is increasing.
What are the Consequences of Inflation on Workers?
Real incomes fall with inflation, so workers will have less disposable income.
If firms face higher costs, there could be more redundancies when firms try and cut their costs.
What are the Consequences of Inflation on Consumers?
Those on low and fixed incomes are hit hardest by inflation, due to its regressive effect, because the cost of necessities such as food and water becomes expensive. The purchasing power of money falls, which affects those with high incomes the least.
If consumers have loans, the value of the repayment will be lower, because the amount owed does not increase with inflation, so the real value of debt decreases.
What are the 3 Causes of Inflation?
Demand Pull
Cost Push
Growth of the Money Supply
What is Demand Pull Inflation?
This is from the demand side of the economy
When AD is growing unsustainably, there is pressure on resources/spare capacity/LLCE. Producers increase their prices and earn more profits.
It usually occurs when resources are fully employed.
(Shown by shifting AD right on the LRAS curve)
What is Cost Push Inflation?
This is from the supply side of the economy, and occurs when firms face rising costs.
It is to do with a short run supply shock, which increases the cost of production, shifting SRAS left/up
As firms face an increase in their cost of production, they’re more likely to pass on these extra costs to consumers; increasing the price level and thus causing cost push inflationary pressure
(Shown through shifting SRAS left)
How does the Growth of Money Supply cause Inflation?
Growing the money supply will cause increased inflationary pressures, as individuals + firms may spend their excess money on goods + services, raising AD.
In addition, the increase in the demand for labour resulting from higher demand for goods + services* will cause a rise in wages and costs of production.
*(as labour is derived demand from goods + services)
Who are Unemployed people?
People who are economically active, but are not in employment
The unemployed consist of those registered as able, available and willing to work; but who cannot find work, despite an active search.
Who are Economically Active people?
These of working age who are looking for work
Who are Discouraged Workers?
People who have been unable to find employment, and are no longer looking for work
What is meant by the Workforce?
People who are economically active (regardless of whether they’re employed or unemployed)
What is Underemployment?
Those who are employed, but are not working to their full potential
What are the ways of Measuring Unemployment?
Full Employment
Claimant Count
Labour Force Survey
What is Full Employment?
A situation where people who are economically active in the workforce, and are willing + are able to work, and are able to find employment
How does the Claimant Count measure unemployment?
Claimant Count: The number of people claiming Jobseeker’s Allowance
Monthly Count of the Unemployed
What is the Current Claimant Count?
1.57 million
How does the Labour Force Survey measure unmployment?
International Labour Organisation measure
(Internationally Agreed standard measure of unemployment)
Monthly Count
Survey of 60,000 households (100,000 adults ish). They have to tick a box if they fit the ILOs definition of unemploymeny
What is the Current Labour Force Survey Count?
2.53 million
What is Structural Unemployment?
Occurs when there is a long term decline for the goods + services in an industry
It is to do with the Immobility of Labour (occupational or geographical)
Occupational: It is very difficult to find work in another industry if the skills they have aren’t transferable or needed
Geographical: Workers are not willing to move to a different place to find a job
Also, labour may be replaced by Capital (Machinery)
What is Frictional Unemployment?
When you have left a job, and are looking for another
This is very common; and also why there can never be 100% full employment
What is Cyclical Unemployment?
When there is a lack of AD in the economy, here is less demand for labour:
Labour is derived demand for goods + services. If the demand for them falls, the demand for labour falls.
Firms are either forced to close, or make workers redundant due to failing profits
A decrease in AD always means an increase in cyclical unemployment
What is Seasonal Unemployment?
Some season/weather based industries require more employment at peak demand times.
Workers will only be unemployed for seasons/periods, until there’s peak demand again
What is Real Wage Inflexibility?
Classical Economists argue that if you let Wages Fall to the Equilibrium Level, there would be no Unemployment.
Because Wages are Above this level, there is Unemployment. This is due to excess supply
What are the Benefits of Unemployment to the Individual and Businesses?
Individual:
More Leisure Time
Redundancy Pay
Businesses:
Bigger Pool of Surplus Labour
Less Pressure to Pay High Wages
Less risk of Industrial/Strike Action
What are the Benefits of Unemployment to the Economy and Society?
Economy:
Less Income = Less Spending = Less Demand = Lower Inflation
Society
Increased chance of Volunteer Work
What are the Costs of Unemployment to the Individual and Businesses?
Individual: Loss of Income Fall in Real Living Standards Increased Health Risks Stress/ Possible Marital Problems Social Exclusion (Stigma) The Longer the Duration of Unemployment, the Lower the Chances of Finding Fresh Employment
Business:
Fall in Demand for Products
Negative Multiplier Effects
What are the Costs of Unemployment to the Government, the Economy and Society?
Government: Increased Spending on Unemployment Benefits Fall in Revenue from Income Tax Fall in Revenue from Corporation Tax May lead to a Budget Deficit
Economy:
Lower GDP
Unemployment can be seen as an Inefficient Way of Allocating Resources -> Labour Market Failure
Fall in Potential GDP if the Unemployed Completely Leave the Labour Force
Increase in Inequality
Society:
Increase in Crime, Violence + Vandalism
Areas become Run Down
Increased Depression
What ways can Unemployment be Reduced?
- Education (= More Qualifications + Skills)
- Lower Taxation (=More money Firms Get)
- More Job Advertisements’
- Raise AD Levels
- Give Subsidies to Small Businesses
What is the Significance of Changes in Employment + Unemployment (for consumets, firms, workers, the government + society)?
Consumers: If consumers are unemployed, they have less disposable income and their standard of living may fall as a result. There are also psychological consequences of losing a job, which could affect the mental health of workers.
Firms: With a higher rate of unemployment, firms have a larger supply of labour to employ from. This causes wages to fall, which would help firms reduce their costs.However, with higher rates of unemployment, since consumers have less disposable income, consumer spending falls so firms may lose profits. Producers which sell inferior goods might see a rise in sales. It might cost firms to retrain workers, especially if they have been out of work for a long time.
Workers: With unemployment, there is a waste of workers’ resources. They could also lose their existing skills if they are not fully utilised.
The government: If the unemployment rate increases, the government may have to spend more on JSA, which incurs an opportunity cost because the money could have been invested elsewhere.The government would also receive less revenue from income tax, and from indirect taxes on expenditure, since the unemployed have less disposable income to spend.
Society: There is an opportunity cost to society, since workers could have produced goods and services if they were employed.There could be negative externalities in the form of crime and vandalism, if the unemployment rate increases.
What is the Significance of Changes in Inactivity?
If the number of the economically inactive increases, the size of the labour force may decrease, which means the productive potential of the economy could fall.
What is the Significance of Migration + Skills for Unemployment?
Migrants are usually of working age, so the supply of labour at all wage rates tends to increase with more migration.
Migrants tend to bring high quality skills to the domestic workforce, which can increase productivity and increase the skillset of the labour market.
This could increase global competitiveness.
Migrant labour affects the wages of the lowest paid in the domestic labour market, by bringing them down. This is because migrants are usually from economies with lower average wages than the UK NMW. However, this impact is only small.
For the medium and higher income households, it is hard to find evidence of worker displacement or depressed wages.
The skills of migrant labour could substitute those of the domestic market, so workers could be replaced. If the skills complement the domestic labour market, there could be a welfare gain through higher productivities.
What is the Real Wage Inflexibility Diagram?
It’s kinda like the minimum wage diagram
What are the Issues of using GDP per Capita as a measure of economic growth?
Doesn’t take into account any income worked abroad + sent back into the country (Remittances).
This would increase the living standards of those in the domestic country
FDI can influence the GDP/GDP per Capita; but a lot of that income will be sent back into the domestic country, and not spent in the country the FDI invests in.
How do you Calculate GNI?
GNI = GDP + Net factor income*
(* income earned by domestic workers/firms - income earned by foreign workers/firms earning incomes at the domestic country)
What can cause Demand Pull Inflation?
The main triggers for demand pull inflation are:
- A depreciation in the exchange rate, which causes imports to become more expensive, whilst exports become cheaper. This causes AD to rise.
- Expansionary fiscal policy: lower taxes or more government spending. This means consumers have more disposable income, so consumer spending increases.
- Lower interest rates makes saving less attractive and borrowing more attractive, so consumer spending increases.
- High growth in UK export markets means UK exports increase and AD increases.
(Mainly, it’s any feature that affects AD)
What can Cause Cost Push Inflation?
This occurs when:
- Raw materials become more expensive, such as when oil prices rise.
- Labour becomes more expensive. This could be through trade unions,for example.
- Increase in Oil Prices: Basically everything is due to oil, so oil is very important. So, an increase will affect everything.
- Depreciation in the exchange rate, which causes imports to become more expensive, which pushes up the price of raw materials.
- Monopolies, using their dominant market position to exploit consumers with high prices.
(Mainly, it’s any increase in the costs of production)
Which cause of Inflation is the Most Severe/ harms the economy the most?
Cost Push Inflation
It not only causes inflation, but reduces growth too.
Demand pull inflation causes a right shift of AD, and promotes productivity, so it’s not seen as too bad.
There’s not much the economy or government can do to control cost push.
What are the Supply side causes of Deflation?
Lower costs of production
Better productivity
Improvement in productive capacity
It is considered okay, and can even be beneficial in the short run
What are the Causes of a Deflationary Spiral?
1) Falling price of goods -
Consumers have an incentive to delay purchases - Consumption is delayed until prices fall further - Reduction in E. Growth
2) Deflation reduces the effects of interest rates. They now want save, instead of borrow
(the real interest rate is the nominal - inflation. if the inflation rate is negative; real = nominal - - inflation = nominal + inflation = positive outcome)
3) Deflation increases the real value of debt.
Firms cut wages as low prices means they don’t need as much (for example). Cutting wages increases real value. Taking out loans further increases debt, discouraging borrowing
How do you work out Real Interest Rate?
Nominal Interest Rate - Inflation Rate
What is the Criteria of the Labour Force Survey?
- Must have Active Sought work in the Previous 4 Weeks
- Available to Start work in the Next 2 Weeks
- 16+
(The criteria is less tight than the claimant count.)
What is the Criteria of the Claimant Count?
There is a very Tight Criteria:
- Resigned in the past 6 months/ Refused the past 3 jobs
- 18 to retirement age
- Savings Cap (If you’ve saved too much, you won’t get it)
- Actively Seeking Work
- Be Available for Work
- Attend Fortnightly Jobsearch Reviews
- Partner’s Income is Taken into Account
What are the Advantages + Disadvantages of the LFS Survey?
+ It is used worldwide, which allows for cross country comparison
- It’s a survey, which can lead to a sampling error
What are the Advantages + Disadvantages of the Claimant Count?
+ Cheaper than the LFS
- Doesn’t include all unemployed people (there’s a high criteria to receive JSA)
- It may be targeted by fraudsters (however it’s not as big as an issue nowadays)
What are some Problems with Both Measures of Unemployment?
It doesn’t include tho who are:
Economically Inactive (discouraged workers; the hidden unemployed- eg part time carers) Underemployed
Doesn’t show the demographics of unemployed people
What is Cyclical Unemployment also known as?
Demand Deficiency
What is meant by a Balance of Payments?
A Set of accounts Showing the transactions conducted between residents of a country, and the rest of the world
What are the Components of Balance of Payments?
Current Account
Capital Account
Financial Account
What does the Current Account consist of?
Trade in Goods
Trade in Services
Investment Income (e.g. remittances)
International transfers (e.g. aid)
(always looks at the VALUE, not volume)
What does the UK Current Account look like?
Trade in Goods: Negative
Trade in Services: Positive
Investment Income: Positive
International Transfers: Negative
We have an overall Current Account Deficit
(especially because the negative value of trade in goods is huge)
What is a Trade Deficit?
Value of Imports > Exports
Why is there a current account deficit in the UK?
-The UK doesn’t really produce many products (We are mainly in the Service Sector).
Therefore, we don’t export as much
Also, the UK has a trade deficit mainly because of Supply Side reasons: These are long term, and hard to rectify
What are the Demand-Side explanations of a trade deficit in Goods?
Strong Growth of Consumer Spending (Imports meet the excess demand)
Strong Exchange Rate (imports cheap, exports dear)
Boom in Home Country
Recession in Foreign Country
What are the Supply-Side Explanations of a trade deficit in Goods?
Lack of Competitiveness of Domestic Exports: Low investment Low productivity High relative inflation High unit labour costs
Insufficient Production of Resources from home country
Research + Development Gap – The UK has a smaller share of global patent
New lower cost competition for the UK
(e.g. China, India + Eastern European countries)
What are the benefits of a trade deficit?
Higher Standard of Living
Better Quality Goods
What are the costs of a trade deficit?
Lower Aggregate Demand -> May trigger a Recession, increase unemployment, etc.
Lower Company Profits and Business Confidence
May worsen the North/South divide (UK- some regions rely more on exports)
What are the Evaluation Points to do with a Trade Deficit?
- Depends on whether it’s demand-side or supply-side factors causing it;
(demand side factors aren’t too worrying, but supply is) - Depends on proportion of AD that (X-M) takes up
- May be other parts of the account that push the current account into a deficit
What is a Trade Surplus?
When the Value of a Country’s Exports > Imports
What causes a Trade Surplus in Goods?
Low Value of the Pound = People overseas buy our products
World Boom = Higher Demand for our products
Recession = Lower Demand for Imports
Improved Quality/ Design/ Availability / Reliability of Products
What are the Benefits of a trade Surplus?
Increase in International Competitiveness
Greater Confidence in UK Economy
Greater FDI:
Foreign Direct investment
(Businesses Opening Factories Abroad)
What are the Costs of a current account Surplus?
Inflationary Pressure: Exports are high, in relation to Imports
Value of the Pound will Increase: Leads to a Fall in International Competitiveness
Living Standards May Fall: Lots of Exports = Less Available for Domestic Consumption
What is the Relationship between Current Account imbalances, and other macroeconomic Objectives?
By selling more exports to foreign countries, the UK will have a greater inflow of money into the circular flow of income. This will increase AD and improve the rate of economic growth. This also positively affects employment
In the UK, during periods of economic decline or recessions, the current account deficit falls. This is because consumer spending falls.
During periods of economic growth, when consumers have higher incomes and they can afford to consume more, there is a larger deficit on the current account.
If imported raw materials are expensive, there could be cost-push inflation in the UK, since firms face higher production costs.
What is the Interconnectedness of Economies through International Trade?
In theory, the sum of all countries’ trade balances should be zero, since what one country exports will be imported by another country.
If the UK’s main export market, such as the EU, faces an economic downturn then demand for UK goods and services will fall, since consumers in the EU are less able to afford imports.International trade has meant countries have become interdependent.
Therefore, the economic conditions in one country affect another country, since the quantity they export or import will change.
What is Aggregate Demand?
Total demand for a country’s goods + services at a given price level in a given time period
(It’s a measure of value, not volume)
What is the AD Formula?
C + I + G + (X-M)
Consumer Spending + Investments + Government Spending + (Exports - Imports)
What Percentage of each Component takes up AD?
Consumption: 60%
Investment: 15%
Government Spending: 25%
Net Exports: around 1%
Which way does the AD Curve Slope?
Downwards
What causes a Shift in the AD Curve?
Economic Growth / AD
What causes Movement along the AD Curve?
Changes in price level cause movement along the demand curve
What are the 3 Reasons why the AD curve slopes Downwards?
Wealth Effect/Real Balance Effect
International Competitiveness Argument
Interest Effect
(They look at how the price level can affect some component of AD)
What is the Wealth Effect/Real Balance Effect?
As the price level decreases, real incomes/the purchasing power are increasing.
This increases consumption, increasing AD.
What is the International Competitiveness Argument?
As the price level decreases, exports become more competitive and imports become less competitive.
This leads to less spending on imports and more selling on exports.
This increases (X-M), increasing AD.
What is the Interest Effect?
As price level decreases, interest rates can be kept lower in the economy*.
*most central banks adopt their interest rate policies to meet the inflation target
Low interest rates stimulate higher consumption + higher interest rates; and reduces the exchange rate, increasing net export.
This increases C + I + (X-M), increasing AD.
What is the Cetirus Paribus within the AD Curve?
There is an inverse relationship between Price Level and Real National Output/Real GDP.
As Price Level increases, ‘C + I + G + (X-M)*’ will decrease, and vice versa.
*This is all INDEPENDENT from Price Level
What is Consumption?
- The amount Households Spend on Goods + Services to Satisfy their Current Wants
- Consumption can be for Both Durable + Non-Durable Goods
What are the Factors of Consumption?
- Asset Prices
- Confidence in the Economy
- Disposable Income
- Interest Rate
- Ease + Availability of Obtaining Loans/ Credit Cards
- Age of the Population
- Level of real disposable income/income tax
How do House Prices Affect Consumption?
- Existing owners of assets (houses, shares, bonds) have High Confidence (due to Higher Wealth) and thus will spend more
- Also, they can sell + re-mortgage if they own a house
How does Confidence in the Economy Affect Consumption?
In a boom, people have higher confidence; which will make them spend more
The opposite occurs during a recession
How does Disposable Income Affect Consumption?
More disposable income means more spending
More income tax means less spending
How do Interest Rates Affect Consumption?
Lower interest rates means a lower rate of return on saving; discouraging saving and leading to more spending
How does the Ease of Obtaining Loans / Credit Cards Affect Consumption?
Low availability of credit reduces how much banks are willing to lend. This reduces the impact of borrowing/lower interest rates. This means less spending
How does an ageing population affect Consumption?
Longer Lives = More Spending
